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Go with the Crowd or Go Your Own Way?

Research says crowds are wise: watch this BBC video or read this book for more on this assertion. But, as another BBC article explains, the crowd is not always right. Witness the 2008 financial meltdown for proof that herd mentality can be dangerous. In fact, most people prefer to fail with the crowd rather than stand out with a different view. Being contrarian is hard work mentally but it can pay off if you take less risk or go for a smart bet.

New research is emerging into how social influence can alter the wisdom of the crowd by steering opinions in a particular direction. That’s where crowdfunding is at. Is it good or bad for you that crowd views and sentiment trend? Well, it depends. Are you an investor, a business looking for funds or a good Samaritan?

If you want to finance a charitable project, you can go to Kickstarter and raise funds. Is crowdfunding good? Sure, donations are hard to raise, so going out to a wide audience makes complete sense. Plus, a good story (aka “charitable cause”) is likely to pull on people’s heartstrings and getting small donations from many is better than hoping for a big legacy from a few.

If you want to finance your business, you can also go to Kickstarter or a number of other crowdfunding platforms to help you find the necessary equity or debt to take your operations onwards and upwards.

But here’s the thing. If you’re on the other side of that equation – i.e. the peer-to-peer lender or investor who is looking to invest in a start up without setting up shop – how do you know if it’s a good idea or not? The UK regulator recently published a review of the industry and found a host of issues that need addressing in terms of marketing projects to retail investors (typically with no previous investment experience):

  • A lack of balance, where many benefits are emphasised without a prominent indication of risks.
  • Insufficient, omitted or the cherry-picking of information, leading to a potentially misleading or unrealistically optimistic impression of the investment.
  • The downplaying of important information. For example, risk warnings being diminished by claims that no capital had been lost or the relevant risk warnings being less prominent than performance information.
  • Loan promotions comparing crowdfunding investing to savings accounts and banking and, in doing so, creating the impression that the lender’s capital was secure.
  • Insufficient information in debt promotions about the taxation of investments.

The FCA says it will monitor the sector and supervise the platforms (which need to comply with its rules), particularly in terms of promoting to retail investors. But that’s no substitute for knowing what you’re signing up to. Attractive returns, after all, are only realised if all goes to plan. And it doesn’t always – business fail, people mislead, projects don’t work out.

If you are an investor looking for a pick up in returns, good for you! But do you know how to assess the investment or compare it to other investments? If you’re unsure, then perhaps E-MONA can help with the analysis groundwork. Courses that could be of assistance include Savings, Debt and All that JazzMoney Never Sleeps and Socially Responsible Investing.

Now let’s get back to the scenario where your business needs funding to expand. For socially positive projects and businesses (e.g. health, education, helping the disabled) it may well be that you can appeal to well-wishers that just want to support the cause and are not looking for returns.

In reality, businesses usually need to pay up to use other people’s funds. How do you figure out what you can afford to offer? And how do you put debt and equity options into perspective?

In its survey the FCA found that crowdfunding promotions aimed at borrowers lacked balance, giving prominence to the benefits of borrowing without a prominent indication of risk in relation to the borrower’s financial circumstances. Do you know how to figure out if your business can support (more) debt?

Good crowdsourcing platforms sign on businesses with a good track record. How do you showcase yours? At the end of the day, if the investment crowd is being urged to be more diligent, then you as the business raising funds need to be able to prove you are trustworthy and deserve their support. Why should the crowd trust YOU?

Perhaps E-MONA can help you crystalize your ideas, determine which financing source is right for you and develop sound plans to present to financiers. It all starts with knowing where you’re at (see Practical Record Keeping), understanding debt (see Savings, Debt and All that Jazz) and how to balance priorities, but then it comes to Business Cash Flow Management (particularly developing cash flow projections). And it doesn’t hurt to know if you can take advantage of schemes promoted by government (see Tax Doesn’t Have to be Taxing).

So whether you’re an investor or a business looking for funding, make sure you have the knowledge to make a sound decision when it comes to crowdfunding and peer-to-peer lending. Social media has made it possible, but don’t get caught up in herd mentality – be rational!

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